February 1, 2005

RETURN TO SENDER:

The fight over Social Security is, above all, about what kind of society we want to have. But it's also about numbers. And the numbers the privatizers use just don't add up.

Let me inflict some of those numbers on you. Sorry, but this is important.

Schemes for Social Security privatization, like the one described in the 2004 Economic Report of the President, invariably assume that investing in stocks will yield a high annual rate of return, 6.5 or 7 percent after inflation, for at least the next 75 years. Without that assumption, these schemes can't deliver on their promises. Yet a rate of return that high is mathematically impossible ...

Q. I am 24 years old. I have $200,000 to invest. I would like to see that $200,000 sum grow to $500,000 within four years. What might be the best way to reach my goal?

--- G.T., Windsor, Conn.

A. Scale back your expectations and settle for less on the upside. Here's why.

The four-year results you seek would require compounded returns of 25.75 percent a year. That's more than twice the average annual rate of return for stocks since 1926. That's almost five times the annual rate of return for government and corporate bonds over that same 78-year time span. That rate of return would surpass the long-term averages put up by investing legends Warren Buffett and John Templeton.

Think you can find a mutual fund manager who can beat the legends? Maybe you can.

Think you alone are that investment wizard? Maybe you are.

But, rather than rely on your extraordinary luck or talent, it's probably a better idea to learn a little history.

"Historical data help you understand what you can expect from the best, worst and ordinary times,'' said Russ Kinnel, a mutual fund analyst with Morningstar Inc. in Chicago.

Statistical information also helps you set realistic expectations for your investments. It establishes a benchmark that can help you forecast a range of returns in the future.

To get started in this review of statistics, look for one book, "Global Investing: The Professional's Guide to the World Capital Markets,'' by Roger Ibbotson, that reviews the history of investment performance around the world.

It's impossible to completely review stock and bond market history in so little space. So, with a little help from Ibbotson Associates in Chicago, let's take a quick look at the historical rates of return for some commonly held assets. All data measure average annual rates of return from 1926 through July 2004.

-- Stocks: 10.3 percent.

-- A blend of government and corporate bonds: 5.62 percent.

-- Cash (30-day Treasury bill): 3.71 percent.

Recent history has taught us that annual averages are products of extremes. Stocks, as measured by the Standard & Poor's 500, delivered average annual returns of 28.5 percent from 1995 through 1999. But, from the end of 1999 through 2002, the S&P 500 cursed investors with annualized returns of minus 14.5 percent. Yet, if one puts those two periods together and tracks the S&P 500 from 1995 through 2002, the average returns look familiar: 10.3 percent, right in line with historical averages reported by Ibbotson Associates.

During a period of deflation no less.
Posted by Orrin Judd at February 1, 2005 1:23 PM

Comments

Are their any other Ivy League economists who keep their life savings in a matress, the way Mr. Krugman apparently does?

Here's Krugman with yet another straw man. For him and those equally inclined, is there really some magical historical rate of return we could all agree upon that would justify returning the ownership and investment responsibility for the fruits of YOUR labor to YOU? The point is Mr. Krugman (et al) thinks he knows better than you and you shouldn't be allowed to risk your own capital to find out how wrong he really is.

Isn't that one of the main selling points of private accounts in the Social Security Reform? In other words that retirees will have funds to leave their children, if the account is in excess of their retirement needs. (or of course if they die sooner than hoped for)

curt: In Florida you had better be able to pay a lot of property tax for that waterfront. Plus anything with a mortgage is subject to outrageous flood insurance. And $200,000 wouldn't even get you an empty lot around here (Gulf coast i.e., St. Petersburg, Tampa, Sarasota area), at least not on the water. Maybe a condo on the water, but even the crummy ones are going for $250,000 and up. And you still pay taxes.

Plus, it is impossible to find an investment with those kinds of returns without assuming loads of risk. If he truly needs the money isn such a short time frame (4 years), he really can't assume that kind of risk.